IBM Earnings Preview:Revenue Decline to Continue

International Business Machines (NYSE:IBM) is set to announce its Q2 earnings Thursday, July 17. In the first quarter of 2014, the company reported a decline in revenues due to currency headwinds and weaker demand from growth markets. This decline was further accentuated by under-performance of the system and the technology division, which is facing low sales volumes, product transitions and market disruptions.

During Q1, the revenues declined by 3.9% year on year to $22.48 billion. Furthermore, the company reported 21% decline in net income to $2.38 billion largely due to workforce rebalancing that impacted the bottom-line by $870 million. While its core software business witnessed low-single-digit growth, due to 5% year-over-year growth in middleware revenues, its Global Technology Services (GTS) revenues declined by 1% primarily due to the negative impact of the sale of the customer care business process outsourcing (BPO) services business in Q4 2013. However, cloud computing and analytics initiatives buoyed Global Business Services (GBS) division revenues, which grew by 2% year-over-year in Q1.

We expect that IBM will continue to report growth for the software segment’s and GBS division’s revenues in Q2. Trends in IT spending indicates that it is on a rebound in 2014 and we expect the company to report growth in revenues from emerging economies, which reported a lackluster performance in the previous quarters. Furthermore, we expect order backlog to improve, which will boost revenues in the future. However, the GTS revenues will continue to disappoint as the company undertakes contract restructuring. We also expect its system and technology division to report another quarter of disappointing results as the company is refreshing its product offering, and demand for its product remains low.

The Middleware and the operating systems divisions are the biggest contributors to IBM’s stock value, together making up nearly 47% of our estimate. This division continues to report good growth on the back of strong brand recognition of its suite of software such as Tivoli, Rational and Websphere etc. Furthermore, these solutions cater to the growing markets that include mobile, social and security tools. Therefore, we expect software division to post robust growth in Q2 as well as in the near future. However, in this earnings announcement, we are closely monitoring the growth in new licenses for different middleware software as it will help us in confirming the growth trend in software development industry.

Revenues From GTS To Remain Tepid

According to our estimates, the global technology service division makes up 21% of IBM’s stock value. Revenues from this division have declined over the past few quarter as a result of contract restructuring and a decline in outsourcing backlog. We expect this trend to have continued in the second quarter, which likely produced a decline in revenues. However, we expect the outsourcing backlog to improve in the second half of 2014 as demand for IT spending picks up, and the company signs more long-term high margin outsourcing contracts.

GBS Revenues To Post Another Quarter Of Growth

The global business services (GBS) division contributes over 11% to IBM’s stock value according to our estimates. In Q1 2014, GBS reported a 2% year-over-year growth in revenue to $4.5 billion, buoyed by growth in Business Analytics (5% growth) and Cloud (50% growth). We expect this trend to power GBS revenues in Q2 and contribute more to the top line performance going ahead.

Server Revenues To Decline

Server and storage division, which was once the cash cow of the company, is witnessing a continuing decline in revenues. The company announced the sale of its x86 server business to Lenovo in Q1, in a transaction that is expected to close later in the year. The x86 division caters to the blade and rack server market, which is facing intense competition from white box (i.e., unbraded) server manufacturers. As a result, we expect x86 server shipments to post a decline in revenues in Q2. Its remaining server businesses—including z-Systems mainframes, the Power line, and its range of high performance computing platforms—each face market transitions that leave them challenged, at present. Due to these factors, we expect this division to under-perform the global server industry, and the overall results to be subdued.

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